Break-even Analysis - Example

The following example illustrates how to do a break-even analysis, given assumptions about selling price, variable and fixed costs. Default values have been assigned to variables. Change variable values and observe the effect.

Break-even Volume           20,000

Selling Price/unit (SP)         $10

Variable Cost/unit (VC)      $5

Contribution/unit (C)           $5

Fixed Costs (FC)                $100,000

 

Volume	Revenue	Fixed costs	Variable costs	Total costs	Profit Impact
X	R	FC	VC	TC	P
0	$0	$100,000	$0	$100,000	-$100,000
5,000	$50,000	$100,000	$25,000	$125,000	-$75,000
10,000	$100,000	$100,000	$50,000	$150,000	-$50,000
15,000	$150,000	$100,000	$75,000	$175,000	-$25,000
20,000	$200,000	$100,000	$100,000	$200,000	$0
25,000	$250,000	$100,000	$125,000	$225,000	$25,000
30,000	$300,000	$100,000	$150,000	$250,000	$50,000
35,000	$350,000	$100,000	$175,000	$275,000	$75,000
40,000	$400,000	$100,000	$200,000	$300,000	$100,000
45,000	$450,000	$100,000	$225,000	$325,000	$125,000
50,000	$500,000	$100,000	$250,000	$350,000	$150,000

• Pricing Strategies

• Gain market share.
  There are various generic pricing strategies.
  Maybe you priced to gain market share. You decide to cut price to lower your margin to get more volume.  This is a strategy of pricing aggressively to gain market share.
• Prevent market entry.
  If you fear other companies may enter your market, then you might price to prevent new market entry by lowering the price and discouraging others from entering a market because there is a significant risk that they might not be profitable.
• Meet competition.
  Sometimes you are faced with matching a competitor's price.  The competition takes an aggressive price action and you have to follow it or you are going to lose market share.  As undesirable as that might seem, it might be the only option available to you.  Once you lose a customer, it can be very difficult to get them back.
• Price leadership.
  If you are in a position where you can exert price leadership, whenever you move your price, everybody usually follows. In many industries, there tend to be certain companies that are price leaders, and if they introduce a price change then the other competitors tend to follow.
  In order to have price leadership there must be some characteristics about your company, perhaps market dominance or a history that would cause that sort of cohesive reaction in the marketplace.
• Prevent cannibalization.
  Cannibalization occurs when you have one product already in the marketplace and you introduce another one and that new product kills the sales of the incumbent product.  In your pricing strategy you might want to introduce the new product at a higher price, go with a low volume and try to go into a transitional stage. Maybe you don’t want your other product to phase out so quickly, so maybe use your price to control cannibalization.
• Milk product.
  As a product nears the end of its life cycle, a "milk" strategy would involve maintaining price and margin allowing market share to decline until the product exits the market.
  Milking" a product typically occurs at the end of a product life cycle.  As sales decline, margins are maintained to maximize cash flow until the product is removed from the market.

The first three strategies typically involve price reductions.

Distribution/Placement

·         Typical Distribution Channels: 

o    Manufacturer 

o    Wholesaler 

o    Retailer 

o    Customer

In typical distribution channels, there is a manufacturer of the product, a wholesaler who acts as an intermediary to the manufacturer who then sells to retailers, who ultimately sell to the customer.

Some manufacturers may decide to go directly to the retailer or the consumer.  There are many choices here in the distribution strategy. You can go through this chain where each intermediary takes a share of the revenue versus trying to go more direct or skip a stage in the distribution channel.

Another factor in distribution is deciding how intensive you want the distribution to be.  How do you decide whether to use selective versus intensive distribution?

·         Selective vs. Intensive Distribution 

o    Selective: 

§  seller's unit costs for stocking are high; 

§  customers are willing travel to location.

When we decide to use selective distribution, it means that there are fewer locations where the customer can buy our product.  We are not everywhere.

We take this approach when the cost to stock our product is very high.  For example for home computers, you might sell through a retail outlet.  The inventory cost is very high for that retailer so you don’t want to license several retail outlets in a small market to sell your product.  Their inventory cost is so high and if you create all kinds of competition for them then you are weakening their position.

Another consideration is whether customers are willing to travel to a location to purchase the product.  For high ticket items like cars, furniture or computers, the customer may be willing to travel to a number of outlets.  But for items like toothpaste, it had better be everywhere.  Because they are not willing to travel all around to buy toothpaste, it needs to be available in every outlet.

A Selective distribution example could be Porsche automobiles.

 

o    Intensive: 

§  seller's unit costs for stocking are low; 

§  convenience for customer is critical.

In intensive distribution the product is everywhere.  An example would be the retailing of gasoline.  If you look at all the major retail outlets, they are on every corner.  In an intensive distribution, the stocking costs are typically very low.  Convenience for the customer is critical.  When they decide that they need gas or toothpaste, you'd better be there.  Convenience is more important to the customer, whereas in selective distribution they are willing to travel to a retail outlet and have fewer choices for that type of product.

·         An Intensive distribution example could be Gillette razor blades

• Direct versus Indirect Distribution 
• Cost of distribution relative to sales.
  How do we decide how to proceed with respect to direct versus indirect distribution?
  How do we decide whether to go directly to the consumer or go directly to the retailer, as opposed to going indirectly through one of the other channels?

First there is the cost of distribution to consider.

Clearly if we go directly to the consumer, we have to consider that consumers are dispersed and distribution  might be more costly than a logistics system that is already established and can realise economies of scale and efficiencies with more volume.  Using the example of groceries, clearly trying to sell groceries directly to the customer at their homes is a lot more inefficient and costly than trying to sell them to a retail outlet where consumers typically show up to buy groceries.

 

• How the customer wants to buy.
  How does the consumer want to buy?  For different kinds of products and services, the consumer typically buys them in a certain way.  Usually they just show up at a grocery store to get groceries.  For a home computer they are willing to shop around.  So how they want to buy is an important factor in how you are going to distribute.
   
• Degree of control required over sales strategy.
  How much control do you want to have over your sales strategy?  The ultimate level of control is when we do everything ourselves.  We produce the product and we actually sell the product to the customer.  As we start to rely on intermediaries like wholesalers or retail outlets, e.g. computer selling at retail outlets, we start to lose control as to how our product is communicated to the consumer.
  That is where you have to design incentives, training or communications for intermediaries to make sure that they represent you properly to consumers.

SUMMARY MARKETING STRATEGY CONCEPTS

The Marketing Mix

The Marketing Mix is a combination of five marketing components that are integrated into the marketing strategy. In the Marketing Strategy the company decides what the most appropriate mix is. These components are also referred to as the 5 Ps :

Product

Market (or Place)

Promotion

Pricing

Distribution (or Placement)

The Product

A Product is a package of benefits as perceived by the consumer. In developing a product strategy you have to address several issues:

·         Determine the product/service need

·         How do you serve the need profitably?

·         Do you have the capability to fill the need?

·         What will the effect be on other products?

·         Will it enhance the company's image?

·         How will the competitors react?

The Market

A "market" is subdivided into market segments. Each market segment represents a group of potential consumers with similar needs and interests. The target market segments are identified in the Marketing Segmentation Analysis. There are many ways to segment a market and they are not mutually exclusive:

·         Demographic: age, gender, family size, marital status, etc.

·         Geographic: language, regions, government, etc.

·         Psychographic: hobbies, lifestyle, interests, etc.

·         Product Usage: frequency, purpose, etc.

"There is no such thing as one market. There are only market segments"

A "Fit" Analysis is carried out to evaluate the market segments against key objectives and issues such as: corporate goals, corporate strengths/weaknesses, growth objectives, market share objectives, competitive threats/opportunities, and the need to maintain focus.

Promotion

Promotion involves communicating the marketing message of your product to the potential buyers. The components of marketing communications strategies are:

• Target
• Intensity
• Message
• Medium (Push versus Pull)
• Economics

The push strategy is more commonly used when you have to deliver a more complex message to the consumer.

Price

What is the appropriate price? Market research can help you estimate what customers are willing to pay.

To set your price you have to understand the relationship between fixed cost, variable cost, contribution, profit impact, and break-even volume. Break-even Analysis is a tool used to analyze these relationships.

You cannot charge any more than what the consumer perceives as the value of the product/service compared to the other available choices.

Pricing Strategies can be set to:

·         gain market share

·         prevent market share

·         meet competition

·         price leadership

·         prevent cannibalization

·         milk product

Distribution

Distribution involves getting the product from where it is produced to where the consumer purchases it. Types of distribution Strategies are:

·         Selective Strategy: the availability of the product is limited

·         Intensive Strategy: the product is available everywhere

·         Direct Distribution: the product goes directly from the producer to the consumer

·         Indirect Distribution: there are intermediaries between the producer and the consumer (e.g. wholesaler, retailer, sales representatives)